Tax 'Reform' May Kill These Companies Even Faster

By Justin Brill

Saturday, December 30, 2017

It's official... Tax "reform" is finally here.

Just before Christmas, Congress passed the most significant changes to the U.S. tax code in more than 30 years. And late last week, President Donald Trump signed the bill into law.

Why do we write "reform"?

Because, as expected, the bill falls short of the dramatic improvements many had hoped for.

It won't simplify the tax code in any meaningful way. It won't make it any less time-consuming or expensive for most folks to file their annual returns. And it won't significantly ease the tax burden for most Americans over the long term.

But it isn't all bad...

According to non-partisan think tank the Tax Policy Center ("TPC"), most Americans should expect to see a modest reduction in their tax bill. The TPC reports 143 million people will pay lower federal income taxes in 2018, compared with just 8.5 million who will pay more.

Overall, the TPC found taxes will fall for all income groups, on average. Folks earning $10,000 or less should expect to keep an extra 0.1%, on average, while those earning $500,000 or more will see an extra 4%. Folks in the middle – those who earn between $50,000 and $75,000 per year – should expect to a see an extra 1.5%, on average.

Congress' own independent auditor, the Joint Committee on Taxation, reported similar results. It found the average tax rate would fall from 20.7% to 19% under the law, including a drop from 14.8% to 13.5% for those in the middle tax bracket.

Unfortunately, these cuts may not last long...

Under the current bill, the individual tax cuts will expire in 2025. If no change is made before then, today's tax cuts will become tomorrow's tax hikes. Under this scenario, the TPC estimates a majority of Americans – including 69.7% of those in the middle – would pay even higher taxes than what they pay under our current law.

To be fair, Republicans say they won't allow these tax cuts to expire. But if they weren't able to pass a permanent tax cut today – under nearly ideal circumstances – how certain is it they'll be able to extend these cuts in the future?

The news is better for many companies...

The plan will permanently slash the corporate tax rate from 35% today to 21%. It will also repeal the current 20% corporate alternative minimum tax, exempt companies from paying taxes on money earned overseas, and lower the "repatriation tax" on overseas earnings from 35% to between 8% and 15.5%.

These changes could drive higher earnings for a huge number of firms – particularly those based in the U.S. – across a range of industries.

But not every company will benefit...

In fact, the plan could create even bigger problems for those carrying large debt loads. As the Wall Street Journal recently reported (emphasis added)...

Full deductibility of interest has long made borrowing more attractive for companies when they needed money, instead of raising capital through selling equity...

The tax overhaul would essentially limit the net interest payments a company can deduct to 30% of its EBITDA, or earnings before interest, taxes, depreciation, and amortization. Any amount above that level would be taxable.

So if a company borrowed $1 billion at an interest rate of 5%, and its existing interest payments were already above the 30% threshold, it would have to pay an extra $10.5 million a year in taxes – $50 million in interest, taxed at the new corporate tax rate of 21%.

In other words, heavily indebted companies that are already struggling – like the troubled firms that Porter and his research team have been following in Stansberry's Big Trade – could soon see the costs to carry those debts soar even higher. More from the Journal...

J.C. Penney (JCP), which has speculative credit ratings and more than $4 billion in debt, said in its third-quarter Securities and Exchange Commission filing in November that disallowing tax deductions on interest "could have a material adverse effect on our results of operations and liquidity."

Weak corporate credits like the aforementioned department-store chain are already unlikely to survive the next credit-default cycle. But despite the bullish headlines, the new tax plan could actually hasten their demise.

Speaking of the next credit-default cycle...

We've been covering the growing risks in subprime auto lending for years. Porter and his team were among the first analysts anywhere to warn of these problems back in 2014.

Clearly, many private-equity investors weren't paying attention. We hope they are now. As Bloomberg recently reported...

Private-equity firms that plunged headlong into subprime auto lending are discovering just how hard it might be to get out...

In the years after the financial crisis, buyout firms poured billions into auto finance, angling for the big profits that come with offering high-interest loans to buyers with the weakest credit. At rates of 11% or more, there was plenty to be made as sales boomed. But now, with new car demand waning, they've found the intense competition – and the lax underwriting standards it fostered – are taking a toll on profits.

Delinquencies on subprime loans made by non-bank lenders are soaring toward crisis levels. Fresh investment has dried up and some of the big banks, long seen as potential suitors, have pulled back from the auto lending business.

In short, these firms are getting squeezed from both sides... Losses are rising on existing loans as borrowers fall further and further behind. Meanwhile, banks are tightening credit in response to rising delinquencies and falling auto sales.

This should come as no surprise to regular readers...

Subprime auto delinquencies have been ticking higher for months. But these problems extend far beyond autos alone... And they're likely to get much worse before they get better. As Porter explained recently (emphasis added)...

The ongoing debt explosion is finally reaching its peak... Lots of consumer loans are starting to go bad. We first saw default rates creeping up in subprime auto loans (as we warned they would).

Now, credit-card default rates are moving higher, too. Soon, the mirage of student lending is going to completely fall apart. That's when we'll see fireworks across the credit spectrum. But that's not all...

Just as defaults are rising, the Fed has begun to raise rates.

Look at what that's going to do to the U.S. government's funding costs over the next few years, according to projections from the Congressional Budget Office. Interest payments will nearly double, going from 6% to 11% of the federal budget...

These rising costs are going to have a profound effect on the current widespread political belief that "deficits don't matter," just as soaring default rates on consumer lending are going to lead to much tougher lending standards on cars, colleges, and credit cards.

All of that consumption that we've enjoyed on credit for the last decade is going to come back to haunt us. All of us.

This doesn't mean the long bull market will end tomorrow... But it will end.

And one of the largest credit-default cycles in history is sure to follow.

As many private-equity investors are likely realizing today, the same problems that markets have ignored for months – or even years – will suddenly "matter" almost overnight.

Porter believes these developments will eventually lead to an all-out "Debt Jubilee." In fact, he says if you open your eyes and look around America today, you'll see it's already underway...

The riots in Charlottesville, Virginia... inner cities burning... more and more radicalized politics – like resurgent neo-Nazi groups and the rise of "Black Lives Matter" protests... These are simply the first signs of a much more serious crisis to come.

Porter recently published a brand-new book, The American Jubilee, to explain how this shocking event is likely to play out... how it will affect you and your money... and most important, a few simple, but crucial steps you can take now to not only survive – but actually prosper – as it unfolds. Get your copy of Porter's new book right here.

Regards,

Justin Brill

Tax 'Reform' May Kill These Companies Even Faster

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